Made money or booked losses in the market? Here’s how you deal with the tax

With the stock market turning volatile due to Covid-induced economic troubles, many investors may have liquidated their investments. Those who seek liquidity may be considering selling their investments, some at a profit and some at a loss.

In this scenario, an investor should understand the tax implications of the gains and losses made on sale of shares, mutual funds, bonds and other instruments. Here’s a primer on the tax aspects.

Holding period, tax rates

Gains or losses made on the sale of shares, mutual funds, bonds, etc are classified as short-term and long-term. This is based on the period for which you have held your investment. Different instruments have different thresholds of holding periods to qualify as short-term and long-term.

The holding period for profits or losses on the sale of listed equity shares to qualify as long-term is above 12 months. If held for 12 months or less, they are categorised as short-term. The same rule applies in the case of equity-oriented funds, including equity-oriented exchange-traded funds (ETFs). Equity-oriented funds are those that have at least 65 per cent of their corpus invested in equity or equity-related instruments.

For debt instruments such as debt-oriented funds (including debt ETFs), the holding period for the gains or losses to qualify as long-term is more than 36 months. The holding period for gains or losses on listed bonds or non-convertible debentures of companies to be categorised as long-term is more than 12 months.

The long-term and short-term capital gains are taxed at different rates. Long-term capital gains on sale of listed equity shares or equity-oriented funds up to ₹1 lakh a year are exempt from tax, and gains above ₹1 lakh are taxed at 10 per cent. Short-term capital gains from listed equity shares and equity-oriented funds are taxed at 15 per cent. There is no indexation benefit (upward adjustment of cost to account for inflation) available on calculation of gains from equity shares or equity-oriented funds.

Long-term capital gains from listed debt securities such as corporate bonds are taxable at 10 per cent without indexation benefit. For debt-oriented funds the tax rate on long-term capital gains is 20 per cent with indexation benefit. Short-term capital gains from listed debt securities and debt-oriented mutual funds are taxable at the slab rate of the investor.

Note that surcharge on tax, if applicable, and cess will also apply in the above cases of tax on long-term and short-term capital gains.

Set off, carry forward

If you make short-term or long-term capital gains or losses, the rules of set-off and carry forward as per the Income Tax Act, 1962, can come in handy. One, capital losses can be set off against capital gains. So, it may sometimes be worthwhile to book losses and set them off against your capital gains to reduce your tax liability. But this would also depend on how long you have held a particular asset.

Two, short-term capital losses can be set off against long-term and short-term capital gains. But long-term capital losses can be set off only against long-term capital gains. So, if you have short-term capital losses from debt or equity, they can be set off against both short-term and long-term capital gains on debt or equity. But if you have long-term capital losses on debt or equity, you can set them off only against long-term capital gains on the same.

Also, in case you have long-term and short-term capital gains (losses) from other assets, these can also be set off using the rules above. Any loss that an investor is not able to set off in a particular financial year can be carried forward for eight years to be set off in the future using the same rules.

Say, you have booked short-term capital gains of ₹40,000 in the recent rally in equities since March 2020 and, at the same time, you made some short-term losses in debt mutual funds of around ₹30,000. You can set off ₹30,000 of your loss from debt funds against ₹30,000 gains in equities.

Say, in another scenario, you made some long-term capital losses on listed shares or equity-oriented funds of ₹80,000 and long-term capital gains of ₹50,000 in gilt mutual funds and short-term capital gains of ₹40,000 in listed shares or equity-oriented funds.

You will be able to set off only ₹50,000 of long-term capital loss on listed shares or equity-oriented funds against long-term capital gains of ₹50,000 on gilt mutual funds. The balance long-term capital loss of ₹30,000 on listed shares and equity-oriented funds can be carried forward for up to eight subsequent years for set-off purposes.

Ifs and buts

- Capital losses can be set off only against capital gains

- Short-term capital loss can be set off against short- and long-term capital gains

- Long-term capital loss can be set off only against long-term capital gains

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